Slovak koruna hits record high after revaluation

WanfengZhou

NEW YORK (MarketWatch) -- The Slovak currency, the koruna, rallied to a record high Monday after the country surprised the market by revaluing its currency 8.5%, triggering speculation that other new members of the European Union will follow suit.

Slovakia gained approval from the European Commission to revalue the koruna's central parity rate against the euro in an effort to control inflation and prevent the Slovak economy from overheating. Slovakia is preparing to join the euro zone in 2009.

The new parity rate stands at 35.4424 koruna, or crowns, to the euro, compared with 38.4550 crowns to the euro previously. The E.U.'s Exchange Rate Mechanism II (ERM II), which countries are obliged to enter before euro adoption, allows currencies to move within a 15% band on either side of the central rate. Slovakia joined the ERM in 2005.

"All in all, we find this decision is very surprising," said Lars Christensen, senior analyst at Denmark's Danske Bank. "There has from time to time been speculation in the market that this could happen, but we have tended to see this as unlikely. It seems we have now been proven wrong."

The revaluation "sits at odds with the recent actions of the Slovak Central Bank," he said.

The decision to revalue the central parity rate follows months of accelerated appreciation of the koruna. However, the Slovak central bank had ruled out a revaluation risk and had intervened in the currency markets on more than one occasion recently by selling the koruna to weaken it.

The move gives the koruna more room to strengthen and hence should attract new investors, said Michal Musak, an analyst at Erste Bank der oesterreichischen Sparkassen AG. The currency had "only limited space until now," he said.

However, "more short-term capital means higher risk of quick swings in case of sudden change of market sentiment," he said. "We now anticipate higher volatility in the coming months."

The revaluation sparked a rally in other Central and Eastern European currencies Monday. The Czech koruna, the Polish zloty and the Hungarian forint all moved higher.

The Slovak koruna last traded up 3.4% at 32.775 against the euro. The forint rallied 1.5%, and the zloty was up 0.4%.

Euro entry

The E.U. said the Slovak revaluation reflects a firm commitment from the government to keep inflation stable and to tackle wage pressures and credit growth.

The revaluation should help reduce inflationary pressures in the country, which will make the planned euro entry in 2009 more likely, said Danske Bank's Christensen.

'There has from time to time been speculation in the market that this could happen, but we have tended to see this as unlikely.'
Lars Christensen, Danske Bank

However, given that the koruna is "probably overvalued" and the country's current-account deficit is large, "there is clearly a risk that Slovakia will join the euro with an excessively strong currency," he said.

The koruna has been one of the strongest currencies in the world over the past year, rising as much as 14% against the euro.

Nigel Rendell, senior foreign-exchange strategist at French Bank Calyon, said it is highly "unlikely" that the European Commission would have agreed to a revaluation of the koruna, unless it believes that Slovakia will qualify for euro membership in January 2009.

"In this respect Slovakia looks 'home and dry,' " the analyst said.

Hungary revaluation

Speculation is now mounting that Hungary's central bank will follow Slovakia's move by abandoning the forint's trading band, as the currency is approaching the higher end of its fluctuation range against the euro.

Hungarian government officials and central bankers have said the issue of abandoning the band is not on the agenda. However, it has not been ruled out, either.

Tania Kotsos, senior emerging-markets strategist at RBC Capital Markets, said whether officially on the agenda or not, "investors could force it on if a speculative attack is launched on the lower end of the band."

The current price action suggests the euro-to-forint rate is heading in that direction, Kotsos said. "For now the pressure on [the euro-forint rate] is to the downside, and we are likely to see it trend down toward 240.01," which is the lower end of the band.

Analysts at RBC expect the forint trading band to be lifted, possibly as early as the second half of the year.

The bank revised its forecast for the euro-forint rate to 241 by the end of June, compared with 248 previously. The rate may hit 236 by the end of the year, compared with an earlier estimate of 259, it said.

Rendell said that by allowing Slovakia to revalue its currency, the European Commission has bent the convergence rules, which require a country to avoid exchange-rate volatility. The ERM II rules mean "avoiding both a devaluation and a revaluation," the analyst said. "This condition has effectively been 'waived' for Slovakia and may encourage the E.C. to take a softer line with other potential euro candidates."

The Baltic republics Latvia, Estonia and Lithuania have postponed their plans to join the euro, hurt by currency volatility and weak economic fundamentals, including overheated economies, soaring inflation and large current-account deficits. See related story.

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